Possibility of rate cut in Korea rises

Growth is slowing more than expected while the predicted recovery is being delayed, says DBS.

DBS Group Research noted:

Chances increased significantly that the Bank of Korea will make a consecutive rate cut at the August meeting scheduled next Thursday. Growth is slowing more than expected, and the predicted recovery is being delayed.

The full year GDP growth is very likely to miss the BOK’s forecast of 3.0% just announced in July. Even our downgraded forecast of 2.7% now appears slightly optimistic.

The latest economic data for July surprised on the downside. Exports fell sharply by -8.8% YoY (-3.5% MoM sa) and manufacturing PMI dropped to 47.2, which point to a further slide in industrial production in the same month.

Meanwhile, given the continued decline in capacity utilization, the recent plunge in machinery orders and business sentiment, investment in the manufacturing sector is likely to contract further in 3Q. In line with the slowdown in aggregate demand, CPI inflation also eased rapidly to 1.5% YoY in July, significantly down from 2.2% in June.

Now it seems inflation will average at 2.0-2.5% in the full year of 2012, also lower than the BOK’s forecast of 2.7%. The actual inflation rate excluding the distortion impact of fiscal subsidies is estimated to be in the range of 2.5-3.0% this year.

We believe there is enough flexibility for the BOK to cut rates further from the current level of 3.0%, taking the short term real rates towards 0% so as to lend more support to the domestic economy.

The best timing for further rate cuts is in August-September, in our view. This is because the year-on-year inflation numbers will likely bottom in Jul/Aug before gradually picking up in September, considering the base effects from last year.